In my 2007 book ‘The Generation Game’, I wrote “Anglo Irish bank is little more than an out-of-control hedge fund leveraging themselves and their clients into property”. The lawyers for the publishers insisted that the name Anglo be dropped, for fear of litigation. So the published sentence replaced the words Anglo Irish Bank with the more general “certain well-known Dublin banks”.
And it wasn’t just me; many others had concluded this about the Irish banking system, yet the authorities did nothing.
Looking at the Anglo trial, one thing that really stands out was the complicity and the knowledge of the State in this illegal act. It has been truly breathtaking to see that the main financial institutions of the State – the Central Bank, the Financial Regulator and the Department of Finance – were all aware that Anglo was lending money to people in order to ramp up its share price artificially, but did nothing. Yet they were happy to continue to describe the banks as “well capitalised” right up to the end.
This is remarkable.
This is real Banana Republic stuff: the State knows something is illegal but rather than face it, it looks the other way. This type of behaviour goes to the root of the Irish banking crisis and, although there have been some changes at the top, the question is whether it could happen again?
The favoured narrative is that Anglo was uniquely delinquent. It may have been uniquely criminal, and that remains to be seen, but it is not the case that it went about its daily business much differently to any other institution. Remember, every single Irish bank was bailed out by the Government in 2008. Read this again. We are talking here about systemic and institutional failure on a monumental scale.
And the banks did not go bust overnight. They went bust, to paraphrase Ernest Hemingway, in two ways: first slowly, then quickly.
The economist, John Mills, said the following of crashes: “The crash doesn’t destroy wealth, it merely reflects the extent to which wealth has already been destroyed by bad investments made in the boom.”
Wealth here was not destroyed by the crash but by stupid decisions made in the boom, driven by the effervescence of the herd and fuelled by reckless lending. The banks went bust initially slowly. Every time some madcap dream of a developer was financed, ordinary depositors’ deposits were put at risk. When those loans went bad, the bank had to find the money to make up the shortfall. This is what the regulator is paid to spot – years before it gets out of hand. The financial authorities were not up to the job. Regulators are paid to spot the slow bit of the process, which prevents the fast bit of the bust.
Banks should be afraid of the regulator. If they are not, banks have an almost inbuilt tendency to lend too much during a boom, pushing up share prices. Share prices rise with profitability but, the more profitable a bank is in a boom, the more risk it is taking.
Rather than celebrate bank profits, a regulator should feel queasy, call the bank in and impose limits on lending. But it seemed that in Ireland, the regulator was happy to just watch from the sidelines and cheer on bank profits, continuing until the very end to say that the banks were “well capitalised” when, in fact, the opposite was the case.
From 2003 on, the rapid expansion of property lending was largely financed with loans from international investors. From less than €15bn in 2003, international borrowings of the six main Irish banks rose to almost €100bn (a lot more than half of GDP) by 2007.
There is a tendency to blame Anglo for everything as if in some way it was acting alone. This was not the case. They were all at it.
To put the banks’ borrowings in context, AIB and Bank of Ireland (BoI) doubled their total loan books in three years. BoI took more than a century to build a loan book of €63bn and then, in three years, from 2003 to 2006, it doubled it.
The slow bust was the reckless lending and the reckless borrowing to finance that lending, which began in 2000 and went into overdrive in 2003/4, culminating in the crash of 2007/8.
The reason banks have to be watched so closely is that their assets are long term, but their liabilities are short term. This means they can get caught out easily and actually run out of money quite easily, too.
Take an ‘asset’ such as a mortgage. It has a 30-year lifespan, so it is very long term. However, the liability the bank has to correspond with this asset could be a retail deposit.
It, or a corporate deposit, could be called in overnight or maybe at most in one year. Interbank deposits are another significant component and these are typically less than a year in maturity for the most part and normally less than three months.
This means that banks can run out of money easily because their capital is only the difference between their assets and their liabilities. If the price of their assets is falling and their liabilities are being called in, they run out of money.
This is why banks first go bust slowly and then very quickly.
When our banks went bust, the Government had to act because AIB was on the brink of bankruptcy and this risked all the deposits in AIB being lost in the inevitable bank run.
Some argue now that the bank guarantee is the root of the Irish banking crisis. However, this cannot be true because the guarantee was the reaction to banks being bust. Had they not been bust there would have been no need to do anything.
The guarantee was the consequence of the Irish banking crisis, not the cause.
The crisis stared in 2000, not 2008. In fact, by 2008 it was all over.
By then, the Government had to act to protect deposits. It could not do this by merging bad banks with good ones because there were no good banks in the country. Every single bank in Ireland needed a bailout. They all needed help.
The State could have nationalised the banks there and then – but that would not have protected taxpayers. The Government could have let them go bust. The State could have let go of toxic banks but AIB, the biggest bank in the country, was on the verge of bankruptcy. Would letting AIB go have been a good idea? How many depositors would have lost everything?
The State could have grabbed hold of the country’s deposits and borrowed heavily as it did in Cyprus to try and make up the shortfall. Would that have worked?
There is a narrative in Ireland that blames the guarantee for everything, as if there was some other easy, painless option. There wasn’t. We didn’t even have a bank resolution mechanism in place. And – even more amazingly – we still don’t.
The bailout, troika and guarantee were all the consequences of the years of reckless lending and pathetic regulation that went before. All the banks were complicit.
What we saw at the recent Anglo trial was that even at the eleventh hour, the Financial Regulator, Central Bank and Department of Finance bosses were all prepared to look the other way.
David McWilliams writes daily on international economics and finance at www.globalmacro360.com